We have been tracking the effects of sustained high inflation on our portfolio of multifamily real estate syndication holdings. We thought a quick update, in Fall 2022, might be of interest to some readers. We took a close look at the Q3 reports from about 10 of our holdings to draw these conclusions. Most are in the Sunbelt of the United States but a few are in the Midwest.
- The first obvious effect is higher rents can be charged at some properties, especially in the hot markets of Texas, Florida, and the Carolinas--higher even than expected in the pro formas. The increases have appeared to be less high in the Midwest. A couple of our properties are showing a "gain to lease," which is a fairly unusual state of affairs. Most of the time investors can expect a "loss to lease" instead, meaning the operator is not able to capture the full expected rents at the property. In a "gain to lease" scenario, the rents are coming in ABOVE the expected rates in the pro forma. This is tough news for renters and good news for investors, of course.
- A second big effect is the higher cost of debt. For new investment properties, we have seen proposed deals coming in with interest rates as high as 8.5% - 9.0%. That is a far cry from the 3.0% - 3.5% of 2020 and 2021 for some deals. With prices still high to acquire the properties in many places, the economics of deals with that type of interest rate means that they are not promising at this time. That's surely one of the reasons fewer good deals are being offered by syndicators to investors at this time. For existing properties, the higher cost of debt is a mixed bag. That's because for properties with long-term fixed debt, there's no effect at all--these deals are looking great on paper right now, because the income side keeps going up with inflation while the cost of the debt remains the same. For properties with variable rates, we are seeing some pain--the rise in rates has been very steep. Ideally, the syndicator bought a rate cap and that will kick in sooner or later (effectively an insurance policy against much higher rates, which can return some cash to the balance sheet), but still, the economics of deals with variable rates can be going in the wrong direction in a hurry.
- Inflation is also affecting the costs of things the operators have to pay for. That includes salaries for staff, the costs of goods and services, and the prices charged by contractors doing value-add work. Some of these costs can be passed on directly to tenants (e.g., some utilities). Others have an adverse effect on the investment's bottom line.
In summary, the news is mixed. For those properties acquired a few years ago with fixed debt of 3.2% or the like, the rising rents mean that investors are doing very well right now. For properties acquired more recently with variable rate debt, there is some pain involved especially up to the point at which any rate cap kicks in (and perhaps major pain for those who decided to forgo a rate cap). For properties relying heavily on value-add investments, there's additional costs that will have to be recovered. And for new deals, well, there's a lot less going on--perhaps until prices to acquire properties come down substantially or if something breaks in terms of interest rates. We'll keep monitoring the situation and welcome hearing what's going on in your portfolio, too.